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2007 Paper AM - Q.2 Ingrams IRR calc for nom return


Hi there,

Cant understand IRR calc for nominal req rate of return.

Arent PV (the current portfolio) 4m, and payments both negative inputs, as PV always negative ?? and withdrawals / pmt 205,000 going out from it

I worked out the answer just using PV as neg, leaving Payments and FV positive as this is what you want to be left with, just to see what the result was and you get i/y 4.84% - same answer.

2 options given in answer key:
1) N = 35 PV 4m pmt -205,000 FV -3m, I/y = 4.84%
Pmt and FV neg here. dont understand.

2) N = 35 PV -4m pmt 205,000 FV -3m, I/y = 4.84%
Both PV and FV neg here. dont understand.


Thanks very much.

Comments

  • Hi @adossa3‌ it seems your question isn't related to 2007 paper q2 at all but a general PV question, not sure if i understood correctly?



    2) N = 35 PV -4m pmt 205,000 FV -3m, I/y = 4.84%
    Both PV and FV neg here.

    For your #2 when you compute I/Y the answer seem to be 0.678% and not 4.84%


  • Hi Vincentt,

    Yes, its 2007 Q1 - having trouble pasting from the exam PDF here.

    the ingrams have 4m as current portf. they need to leave 3m in current dollars 35 years down the road, and their inflation adjusted living expenses are 200,000 x 1.025 = 205,000 for the next year.

    2 answer options given in answer key:
    1) N = 35 PV 4m pmt -205,000 FV -3m, I/y = 4.84%
    Pmt and FV both neg inputs here. dont understand.

    is it because they are both portfolio OUTFLOWS that the sign is neg ?

    2) N = 35 PV -4m pmt 205,000 FV -3m, I/y = 4.84%
    Both PV and FV neg inputs here. dont understand.
    Nominal pre-tax return to be calc.

    Answer:
    Real req return 4.84%
    Inflation adjustment 2.5%
    Nominal pre-tax return 1.0484 x 1.025 = 1.07461 or 7.46%

    Many thanks
  • I think you had a typo in the signs for the second one in your first post.

    Basically, it doesn't really matter which sign you use for PV vs PMT and FV, but the key is that PMT and FV must always have the same sign, meaning if you decided to use negative for FV you have to use negative for PMT.


    N=35, pv = 4 million, pmt = –205,000, fv = –3 million, compute i/y = 4.84%
    The above is from a portfolio's perspective. Assumingthere's 4million in a portfolio and it's paying off (cash outflow from portfolio - negative) to you for 35 periods and at the end you will get 3million (cash outflow from the portfolio - negative).



    N=35, pv = –4 million, pmt = 205,000, fv = 3 million, compute i/y = 4.84%

    This is from your perspective, you invested (cash outflow - negative) 4m and you received 205k (cash inflow - positive) for 35 periods and at the end you'll get 3m (positive).

    Same concept, just inverted signs.


    However, with this
    2) N = 35 PV -4m pmt 205,000 FV -3m

    You will not get 4.84%

    It's saying you invested 4m, you get paid 205k for 35 periods (7.175m) and at the end you will have an outflow of 3m which means you would have a total income of 175k (7.175m - 4m - 3m).

  • Thanks very much Vincentt. Clear now. You are a whizz :-)
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